Uncertainty, co-ordination and path dependence

Our objective is to assess whether dynamics hinder or assist co-ordination in a game with strategic complementarities. We study two dynamic aspects: different agents make decisions at different points in time; and extra information about a payoff-relevant state of nature becomes available over time. We find that the dynamic resolution of information matters most for uniqueness of equilibrium. This is demonstrated by showing that the condition for uniqueness is weaker when learning occurs. We also analyse how successfully agents co-ordinate when there is a unique equilibrium. Finally, we show that path dependence occurs: the order in which signals arrive matters, as well as the total amount of information received.     

THE ECONOMICS OF ILLUSION*

When individuals choose not only goods, but also how to process information, there is a bias: people tend to process information so that they feel good about themselves. This bias is particularly important in voting behavior, where agents have almost no individual effect on public choice outcomes, and therefore almost no incentive for unbiased use of information. Two examples are given. In one example, an adaptation of the classic overdepletion problem, the public chooses not to counteract externalities by appropriate tax policy. In the second example public policy follows the choices of experts, contrary to the interest of the public.     

Information and crowding externalities

Summary. We analyze a model in which agents have to make a binary choice under incomplete information about the state of the world, but also care about coordination with other agents who have the same problem. In some of these situations, the larger the share choosing the same alternative, the better off are agents. In others, if too many people choose the same alternative, agents could be worse off, due to crowding externalities. Agents receive public and private information about the state of the world. We determine whether agents rely more on private or public information, and whether or not their choice behavior is socially efficient. We characterize existence conditions for equilibria in which either all available information, or only the public information is used for decisions, compare the two equilibria in terms of welfare, and analyze the effects of better information. Surprisingly, increasing signal accuracy may be welfare decreasing.Received: 24 March 2004, Revised: 19 November 2004, JEL Classification Numbers: D82. Correspondence to: C. Robert ClarkWe would like to thank Ig Horstmann, Gilbert Laporte, Andrew Leach, Matthias Messner, Bernard Sinclair-Desgagné, Howard Thomas, Nicholas Yannelis, and two anonymous referees for helpful comments. The first author wishes to acknowledge the Strategic Research Grant he received from HEC Montreal for this project.     

On the bad reputation of reputational concerns

Can reputational concerns do any good? Economists have shown how they lead agents to ignore valuable information, to herd, and to become overly risk averse. We explore how they may be a social blessing. An agent may exert effort to become informed about the uncertain benefits of a project. A smart agent's efforts make him better informed; a dumb agent's efforts are to no avail. If an agent does not know his type, reputational concerns are socially beneficial. If an agent knows his type, reputational concerns may be socially beneficial. A dumb agent takes inefficient, unconventional decisions to mimic a smart agent. The latter exerts more effort in order not to be mistaken for a dumb. This holds whether or not project rejection is a safe haven for the dumb.     

Competitive equilibria with limited enforcement

We show how to decentralize constrained efficient allocations that arise from enforcement constraints between sovereign nations. In a pure exchange economy these allocations can be decentralized with private agents acting competitively and taking as given government default decisions on foreign debt. In an economy with capital these allocations can be decentralized if the government can tax capital income as well as default on foreign debt. The tax on capital income is needed to make private agents internalize a subtle externality. The decisions of the government can arise as an equilibrium of a dynamic game between governments.     

The Impact of Power Distance and Uncertainty Avoidance on Real Options Exercise: Potential for Suboptimal Time Delays and Value Destruction

Real options (RO) valuation has been promoted as a way to evaluate investment opportunities and make investment decisions that takes into account the value of managerial flexibility in the face of uncertainty. Although RO enjoys a substantial body of literature considering its application and suitability in different situations, the impact of national culture on the application of RO has received little attention. Values embedded in national culture affect the behavior of managers. In particular, these values play a role in how managers frame information, communicate, and make decisions, directly and indirectly affecting behavior through cultural layers such as organizational culture. National culture, therefore, can systematically affect the application of RO, potentially leading to suboptimal outcomes. In this article, we hypothesize how 2 particularly relevant dimensions of culture, power distance and uncertainty avoidance, affect RO exercise, and estimate the magnitude suboptimality of these effects using a model we develop for the case of a put option. Our estimates suggest RO may not always be a superior valuation approach to net present value for national cultures with certain characteristics.     

Incomplete preferences and rational intransitivity of choice

Do violations of classical rationality theory imply that agents are acting against their self-interest? To answer this question, we investigate whether completeness and transitivity necessarily hold when agents choose outcome rationally—that is, their choice sequences do not lead to dominated outcomes. We show that, because of the danger of money pumps and other manipulations, outcome rationality implies that agents must have transitive psychological preferences. Revealed preferences, on the other hand, must be complete since agents can be forced to choose from any set of options. But these justifications of transitivity and completeness cannot be combined. We show that if psychological preferences are incomplete then revealed preferences can be intransitive without exposing agents to manipulations or violating outcome rationality. We also show that a specific case of nonstandard behavior, status quo maintenance, is outcome-rational in the simple environments considered in the experimental literature, but not in more complex settings.     

Non-manipulable division rules in claim problems and generalizations

When resources are divided among agents, the characteristics of the agents are taken into consideration. A simple example is the bankruptcy problem, where the liquidation value of a bankrupt firm is divided among the creditors based on their claims. We characterize division rules under which no group of agents can increase the total amount they receive by transferring their characteristics within the group. By allowing agents’ characteristics to be multi-dimensional and choosing the meaning of variables appropriately, our model can subsume a number of existing and new allocation problems, such as cost sharing, social choice with transferable utilities, income redistribution, bankruptcy with multiple types of assets, probability updating, and probability aggregation. A number of existing and new results in specific problems are obtained as corollaries.     

PROFITABLE STRATEGIC DELEGATION WITH CONJECTURAL VARIATIONS

Firms delegate strategic decisions to managers because they find it profitable to do so. In the product market, when agents make conjectures about the reaction of their rivals to marginal changes in their own strategies, the set of equilibriums can be enlarged with respect to the case of no conjectures. This paper takes a duopolistic linear market parameterization where firms selling differentiated products can delegate either price or output decisions to managers. We show that it is a dominant strategy for firms to delegate no matter whether firms are Cournot or Bertrand competitors, although the equilibrium is not necessarily efficient. Futhermore, in equilibrium Cournot competition is more profitable for firms than Bertrand competition. Finally, requiring consistency in conjectures yields the same outcome no matter what type of strategic interaction and managerial choice there is on the part of firms.     

General equilibrium, markets, macroeconomics and money in a laboratory experimental environment

Summary. This paper studies a version of war of attrition where two agents with private information make irreversible investment decisions in continuous time. It analyzes a monotone equilibrium where the amount of delay in the timing of decisions is a monotone function of the strength of ones private signal: an agent with a clear signal makes a prompt decision, whereas an agent with a weak signal delays a decision to gather more information from the move of the other agent. Equilibrium delay is characterized under different assumptions about the number of investment options available.Received: 4 October 1996, Revised: 16 May 1997, JEL Classification Numbers: C72, D82, L13.Masaki Aoyagi: I am very grateful to an anonymous referee of this journal for helpful comments. I also thank seminar participants at the University of Tokyo and Kyoto University.     

Why conditional aid does not work and what can be done about it?

This paper studies a simple reform that introduces ex post incentives for the donor to reward good policies—contrary to existing practices. Instead of committing aid to each recipient ex ante and making aid conditional on reform, the donor centralizes the disbursement decision by committing aid to a group of countries. The actual amount disbursed to each individual country would depend on its relative performance. This explicit linkage of the allocation and disbursement decisions has two important advantages as compared to present practices. First, it raises the opportunity cost of disbursing aid ex post, thereby giving the donor stronger incentives to reward good policies. Second, competition among recipients allows the donor to make inferences about common shocks, which otherwise conceal the recipient's choice of action. This enables the donor to give aid more efficiently.     

Decentralized decision-making in a large team with local information

We study a problem involving a team of agents each associated with a node in a chain. Each agent makes a decision that influences only his own cost and those of adjacent agents. Prior to making his decision, each agent observes only the cost structure associated with nodes that can be reached by traversing no more than r arcs. Decisions are selected without any coordination, with the common objective of minimizing average cost among agents. We consider such decisions decentralized since agents act based on different information. Cost incurred by an optimal centralized strategy, in which a single decision-maker has access to all information and dictates all decisions, is employed as a performance benchmark. We show that, to maintain a certain level of performance relative to optimal centralized strategies, decentralized deterministic strategies require r to be proportional to the number of agents. This means that the amount of information accessible to any agent should be proportional to the total number of agents. Stochastic strategies, on the other hand, decentralize more gracefully—the amount of information required by each agent is independent of the total number of agents.     

Batch queues with choice of arrivals: Equilibrium analysis and experimental study

We study the decisions agents make in two queueing games with endogenously determined arrivals and batch service. In both games, agents are asked to independently decide when to join a queue, or they may simply choose not to join it at all. The symmetric mixed-strategy equilibrium of two games in discrete time where balking is prohibited and where it is allowed are tested experimentally in a study that varies the game type (balking vs. no balking) and information structure (private vs. public information). With repeated iterations of the stage game, all four experimental conditions result in aggregate, but not individual, behavior approaching mixed-strategy equilibrium play. Individual behavior can be accounted for by relatively simple heuristics.     

The necessity of delaying economic adjustment

I give an explanation for why agents react with a delay to decision and expectation parameters, by showing that imperfect agents must adjust very slowly relative to optimally adjusting agents if they begin reacting as soon as the latter agents would react. The results follow from the hypothesis of imperfect choice alone irrespective of whether there are any information, search, transaction, or other costs of adjusting decisions. The results thereby provide a general reason for observing inertially lagged behavior, and also agree with recent asset market experiments whose dynamics are governed by adaptive rather than ‘rational’ expectations.     

Viewpoint: The human capital approach to inference

The purpose of this essay is to discuss two approaches to inference and how “human capital” can provide a way to combine them. The first approach, ubiquitous in economics, is based upon the Rubin–Holland potential outcomes model and relies upon randomized treatment to measure the causal effect of choice. The second approach, widely used in the pattern recognition and machine learning literatures, assumes that choice conditional upon current information is optimal (or at least high quality), and then provides techniques to generalize observed choice to new cases. The “human capital” approach combines these methods by using observed decisions by experts to reduce the dimensionality of the feature space and allow the categorization of decisions by their propensity score. The fact that the human capital of experts is heterogeneous implies that errors in decision making are inevitable. Moreover, under the appropriate conditions, these decisions are random conditional upon the propensity score. This in turn allows us to identify the conditional average treatment effect for a wider class of situations than would be possible with randomized control trials. This point is illustrated with data from medical decision making in the context of treating depression, heart disease and adverse childbirth events.     

Household tax evasion

Household members share public goods and make intra-household transfers. We show how these features of the household interact with the tax evasion decision, and identify the dimensions in which household evasion differs from individual evasion. In the model we present two members of a household choose how much to contribute to a household public good and how much self-employment income to evade. We are interested in how different evasion possibilities interact with the contribution decisions to the household public good and the role of income transfers within the household. We show the household evasion decision differs from the individual decision because it affects the outcome of the household contribution game. When household members are taxed as individuals neutrality applies when choices are not constrained. If the evasion level of one household member is constrained then an income transfer can generate a Pareto improvement. When the household members are jointly taxed there is a couple constraint on strategies and corner solutions can emerge.     

Analysing the effect of excess cash accumulation on financial decisions

In this current moment of crisis it is very important for firms to hold a suitable amount of cash. But it is also very important to analyse how this amount of cash affects firm value. Here an in-depth study is made of the determination of firm value centring our attention on the problem of excess cash accumulation. This article adds important value to the existing literature since, employing the panel data methodology in the sample of Spanish nonfinancial firms, it identifies whether excess cash holding affects firm value in general, and investment, financing and dividend decisions in particular. The results show how asymmetric information among the economic agents of the firm affects the cash reserves. In particular, shareholders could penalize the investment made by these firms and consider the positive effect that the debt in particular and the dividend policies exert on the firm. Moreover, the results reveal the importance of financial flexibility as opposed to the arguments provided by agency theory.     

Durability in a Monopoly With a Small Number of Buyers

This paper shows that the number of buyers is a crucial demand characteristic for a monopolist's choice of durability. When he sells to a few large buyers, he offers a more durable good than when selling to many small buyers. By increasing durability of the good sold to large buyers, the monopolist encourages current purchasing and can thus engage in greater intertemporal price discrimination and make more profit. Therefore Bulow's proposition of minimal durability does not survive in the case of few buyers. This has not been pointed out thus far.     

Efficiency of continuous double auctions under individual evolutionary learning with full or limited information

In this paper we explore how specific aspects of market transparency and agents’ behavior affect the efficiency of the market outcome. In particular, we are interested whether learning behavior with and without information about actions of other participants improves market efficiency. We consider a simple market for a homogeneous good populated by buyers and sellers. The valuations of the buyers and the costs of the sellers are given exogenously. Agents are involved in consecutive trading sessions, which are organized as a continuous double auction with order book. Using Individual Evolutionary Learning agents submit price bids and offers, trying to learn the most profitable strategy by looking at their realized and counterfactual or “foregone” payoffs. We find that learning outcomes heavily depend on information treatments. Under full information about actions of others, agents’ orders tend to be similar, while under limited information agents tend to submit their valuations/costs. This behavioral outcome results in higher price volatility for the latter treatment. We also find that learning improves allocative efficiency when compared to outcomes with Zero-Intelligent traders.     

Committees with supermajority voting yield commitment with flexibility

A fundamental problem for government is how to combine commitment to certain policies with the flexibility required to adjust them when needed. Rogoff (1985) [Rogoff, K., 1985. The optimal degree of commitment to an intermediate monetary target, Q. J. Econ. 100(4) 1169–1189] showed that a way to strike the right balance is to appoint an optimally “conservative” policy-maker. In real life, however, policy-makers also have power over decisions where optimal plans are time-consistent, so delegating to a conservative person could be undesirable. A flexible delegation device can be found in a large committee of randomly appointed members voting over policy after observing a shock. When facing dynamic inconsistency, under a single-crossing property, there exists a supermajority rule that implements the population median's optimally conservative policy-maker with certainty. Another single-crossing property guarantees that if simple majority voting is used to select the voting rule that will govern policy choice, the supermajority preferred by the median is chosen. For problems where dynamic inconsistency vanishes, the committee will choose to make decisions by simple majority, implementing median outcomes. An application to monetary policy is developed. We show that the optimal supermajority is higher when dynamic inconsistency is more severe, when preferences are more homogeneous, and when the economy is less volatile.